Is It Worth Going Through Fire And Water For The Central Bank?
2022.05.06 14:25
With investors hitching their wagons to the Fed’s horse on May 4, they still believe that Chairman Jerome Powell can accomplish the impossible. Therefore, it’s all about following the man who will lead you to prosperity. However, while market participants’ faith in the Fed is profoundly short-sighted, I noted on Apr. 27 that pledging allegiance is how investors operate. I wrote:
Thus, while hope is not a strategy, it was clearly a popular opinion on May 4.
Please see below:
GDXJ ETF Chart
To explain, the red line above tracks the one-minute movement of the S&P 500, while the gold line above tracks the one-minute movement of the GDXJ ETF. If you analyze the relationship, you can see that both sank at the outset of Powell’s presser and then rallied into the close. As a result, a little bullish sentiment combined with some short-covering were the perfect ingredients for a sharp daily rally.
However, not only did the pair’s medium-term fundamentals not follow suit, they actually worsened. Therefore, while sentiment rules the day in the short term, their medium-term outlooks couldn’t be more treacherous.
To explain, the FOMC hiked interest rates by 50 basis points on May 4. Moreover, like I have been warning throughout the technical sections of the daily Gold & Silver Trading Alerts, we witnessed a ‘sell the rumor, buy the fact’ event. However, with the Fed increasingly hawked up, investors’ misguided optimism should evaporate over the next few months. An excerpt from the FOMC statement read:
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.”
“In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee decided to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities on June 1.”
As a result, while investors hear what they want to hear, the reality is that hawkish fireworks should light up the financial markets this summer.
Please see below:
CNBC Update
In addition, Powell said:
“We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.”
What are these “tools” he speaks of?
CNBC Update
Thus, with Powell admitting that “blunt tools” are the only mechanism to curb inflation, the Fed’s pathway to lower prices should result in plenty of collateral damage. As a result, while the price action on May 4 suggests that normalization will be easy, the sentiment shift should be profound when reality sets in. To that point, I wrote on Apr. 6:
Furthermore, Powell made the point for me on May 4:
CNBC Update
Also noteworthy, when asked about curbing inflation without impairing the U.S. economy, Powell responded:
“I would say I think we have a good chance to have a soft or softish landing, or outcome if you will. It doesn’t seem to be anywhere close to a downturn. The economy is strong and is well-positioned to handle tighter monetary policy.”
For context, referencing a “softish landing” completely lacks confidence, but it’s Powell’s way of recognizing reality without spooking the financial markets. Moreover, as one of the most important quotes of the press conference, he added:
“I do expect that this will be very challenging; it’s not going to be easy; and it may well depend on events that are not in our control. But our job is to use our tools to try to achieve that outcome, and that’s what we’re going to do.”
As such, with Powell noting that a soft landing “may well depend on events that are not in [their] control,” he’s essentially telling you that the Fed is past the point of managing this outbreak. In reality, inflation is like cancer. Once it spreads, it reaches a point where too much damage has been done to save the patient.
Thus, this is where we are now. With the Fed’s “blunt tools” poised to inflict serious damage on the U.S. economy, the undesirable trade-off of supporting growth versus curbing inflation has the Fed in a material bind. As a result, investors severely underestimate the challenges that will confront them over the next several months.
To that point, remember what I wrote on Apr. 26?
Fed Funds Rate And CPI
Won’t Go Down Without a Fight
Therefore, while history highlights the Fed’s ineptness at handling crises, history also highlights how investors follow the central bank off the cliff. Moreover, while Powell can convince the consensus that “a soft or softish landing” should materialize, please remember that “the fool wonders, the wise man asks.”
To explain, remember what I wrote on Nov. 4 following the FOMC meeting?
And now?
CNBC Update
Likewise, remember what he said about the U.S. labor market and wage inflation? I wrote on Nov. 4:
And now?
As such, investors are either unaware of how wrong Powell has been, or they simply don’t care. However, the comments in italics were made only six months ago. Either way, Fed officials’ inability to see the forest through the trees should have drastic implications over the next several months. As evidence, when the “transitory” camp was brimming with confidence, I wrote on Apr. 30, 2021:
Thus, the situation is unchanged. With Powell predicting that the impossible is achievable, his assertion of “a soft or softish landing” is laughable. Therefore, can you guess where this story is headed next?
Finally, it’s important to distinguish between where we are now and where we are likely headed. Regarding the latter, the “soft landing” crowd will likely be the 2023 version of the “transitory” crowd from 2021/2022. Regarding the former, the U.S. economy remains on solid footing RIGHT NOW. However, the dynamic only adds further fuel to the hawkish fire.
For example, Statistics Canada released its latest international merchandise trade update on May. 4. Now, the data is important because more than 77% of Canadian exports were sent to the U.S. in March. Therefore, the two economies are increasingly intertwined.
To that point, with exports to the U.S. hitting an all-time high of CA $49.234 billion, the data highlights how demand conditions in the U.S. remain resilient. As a result, the Fed’s “blunt tools” still have plenty of work to do.
U.S. Exports
The bottom line? It’s interesting how investors can repeat the same mistakes over and over again. Despite being burned by the Fed during the dot-com bubble and the global financial crisis (GFC), investors remain loyal followers. Moreover, even though the central bank’s inflation and labor market forecasts have been way off, investors’ confidence in Powell remains unwavering. As a result, while ‘fool me twice’ should have been enough, a third rendition will likely emerge over the medium term.
In conclusion, the PMs were mixed on May 4, as gold and silver didn’t participate in the bullish stampede. However, with investors severely underestimating the impact of seven to 12 rate hikes over nine months, the liquidity drain should materially depress the performances of the PMs and the S&P 500 as the drama unfolds.
